Islamic Position of Foreign Exchange Transactions

The existence of several different kinds of dinars (gold coins) and dirhams (silver coins) — by implication, foreign exchange markets — in pre-Islamic Arabia is a historical fact. Foreign exchange dealings involved dinar-dinar, dirham- dirham and dinar-dirham transactions. These dinars and dirhams were full-bodied coins in their base metals. However, there was no universal weight-face value standard for dinars or dirhams issued by different sovereign states. Moreover, lack of precision in minting meant that two dinars (or dirhams) of the same dominion could also have minor differences in their weights. The Prophet (pbuh) ordered trading of gold for gold (dinars for dinars) and silver for silver (dirhams for dirhams) in terms of weight — not by counting.

One obvious implication of this injunction was rationalisation of the trading practices with the Qur’anic ahkam on riba. A less recognised but equally important result related to the own value of a coin vis-a-vis its relative value (in terms of command over other goods). The own value of a full-bodied gold or silver coin was declared to be equal to the weight of its base metal, regardless of the coin’s denomination. In gold- for-silvcr (dinars for dirhams) type transactions, the Prophet (pbuh) allowed the trading partners to follow cither the weight or the counting principle in hand-to-hand exchanges.

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It is very important to note that the Prophet (pbuh) pointedly forbade forward buying and selling in all of the aforementioned cases. Details of these principles may be found under the ahkam of sarrf in Fiqh (Islamic jurisprudence). What conclusions can be drawn for trading of, say, Pakistani rupees for the US dollars?

In modem times, dollars and rupees perform the same basic function as dirhams and dinars did in the early Islamic era, namely, medium for exchange. Rupees are used as measures of exchange for values of goods and services in Pakistan. Dollars play the same role in the USA. Both are generally acceptable in their own countries. This acceptance, however, stems from the legal force behind them rather than any intrinsic value of the papers on which they are printed. By default, rupees and dollars are stores of value, too. Both embody command over resources in their respective economics.

So in a subtle sense, the technical position of a dollar versus a rupee is the same as that of one good vs another or dirhams vs dinars. In other words, both rupees and dollars can be traded for each other like dinars and dirhams. But the parallels end here. Unlike the dinar-dinar, dirham-dirham or dinar-dirham exchanges of the early Islamic days, a dollar- rupee exchange is conducted by counting, at a rate determined in the foreign exchange market. The position of these exchanges vis-a-vis the ahkam of sarrf needs a careful rethinking in view of the nature of the dinars and dirhams and the purposc(s) served by the ban on their forward transactions.

Let us consider an example of a dirham-for-dinar exchange 1400 years ago. Imagine a person X with 100 dinars seeking dirhams. Suppose there was a bunch of dirhams in ready possession of another person Y in the market. Imprecision in minting meant that any two dirhams with Y could be slightly different. The same was true about the dinars with X. When X approached Y, each person had a chance to appraise the other’s “merchandise,” and make a personal evaluation of the same. Suppose both X and Y agreed to exchange 100 dinars with the former for 500 dirhams with the latter — at a 5:1 rale — on the spot. Islamically this was all right. But what did actually happen in “value” terms in this spot transaction?

When X committed to 500 dirhams on spot in exchange for his 100 dinars, from the Shari'ah point of view he was committing to the value (in terms of weight) embodied in those 500 dirhams. Thus the weight of 500 dirhams effectively be came the Shari‘ah-recognised claim of X in silver terms. But if the payment was deferred, the value of the “500” dirhams (in terms of weight of silver) that X was to receive at a later date could be different from that of the 500 dirhams “agreed upon.” In other words, X could end up getting cither more or less than “his” due. In a technical sense, such a discrepancy would tantamount to riba!

Let us now assume that dirhams were not present in the first instance and a forward sale by Y — forward purchase from X’s angle — was proposed at the same 5:1 rate. In this case, the claim of X would be ambiguous in own value terms and the contract inadmissible on ghararr grounds. Riba will not be an issue. But do the riba and ghararr arguments apply to rupee-dollar transactions?

Unlike the dinars and dirhams during the time of the Prophet (pbuh) and Khulafa-c-Rashcdin, at present both rupees and dollars are currency notes. They simply represent means of exchanging property rights for goods and services in their respective economics. No more, no less. The “value” of a bunch of notes is determined by the associated count number. The question of a discrepancy between two rupees at a point in lime as well as across time docs not arise. From the point of view of their respective features, the following are true:

Any two one-rupee notes with different serial numbers but issued on the same date are identical. Similarly, a one-rupee note issued on, say, July 3, 1961, is identically the same as a one-rupee note issued on, say, June 29, 1992. This is also true for dollars. So if X agreed to sell his $100 to Y for, say, Rs 500 and the payment was deferred at Y’s end, X will still receive — and Y give — the same Rs 500 (by count). The picture should be clear now.

The present-day rupees and dollars do not come under the purview of the ahkam of sarrf for the following two reasons:

The ahkam of sarrf basically apply to those monies which have “own” values defined in cardinal units — weight in the ease of gold dinars and silver dirhams.Today, rupees and dollars belong to an entirely different lot. They have no “own” values defined in cardinal units: rupees (dollars) may be exchanged for rupees (dollars) only by count — an ordinal measure.

Unlike the original dinars and dirhams, there is no chance of a change in the “own” value of a due amount whether the deferred payment is denominated in rupees or dollars. So, forward trading of rupees and dollars (at prc-fixcd rates) will comply with the Shari‘ah ahkam on riba and ghararr — the main aims of the ahkam of sarrf.

In order to reconfirm the above-mentioned conclusion, one may also take note of the following possibility: loaning of dinars and dirhams by count was not prohibited; but in such a ease the lender and borrower were required to close the transaction by count. Thus, one can imagine Y securing a loan of 500 dirhams from Z and X receiving 500 dirhams for his 1 (X) dinars in a 5:1 spot exchange from Y. This arrangement serves the same purpose as the forward transaction between X and Y discussed above. However, now Y will be indebted to Z, instead of X. Moreover, at the time of clearing the debt with Z, Y will have to have 500 dirhams — not the 100 dinars acquired from X. There may be economic implications of the deal for Y. But there is nothing wrong per se with this possibility from the point of view of either the ahkam of riba or those of sarrf.

In the light of all these points we are inclined to conclude that there is no problem in the basic concepts of spot and forward foreign exchange markets for today’s rupees, dollars and other currencies. Of course, the forward transactions have to be strictly according to the ahkam on credit transactions in Ayah 282 of Surah al-Baqarah and Ahadith on hai’ muajjal (sale on deferred payment) and hai’ salam (sale with cash payment for future delivery). These include, among others, exchange of one currency for another at a rate mutually agreed at the time of closing the deal. These conclusions do not unconditionally sanctify all forward foreign exchange transactions. A final word will also depend on a given forward transaction also being free from other caveats supporting riba and/or qumar (speculation).